Understanding U.S. Taxation of Multistate and Foreign Corporations

In today’s global economy, where businesses can be conducted virtually anywhere, you may be wondering, “Am I subject to tax in the country where I am selling or generating income?”  

When a foreign company sells to customers in the U.S., several key questions arise:

(1) What is the character of the product or service being sold or income being generated?  

(2) Does the company earn U.S. source income, subject to federal income tax?  

(3) Does the company meet the nexus requirements in any state that would trigger sales tax and/or income tax obligations under state law?  

Similarly, domestic U.S. companies operating across multiple states must evaluate whether their activities create sufficient nexus to require state tax filings, registrations, and ongoing compliance with state-level tax rules.   

Federal Income Taxation on Non-US Persons and Foreign Corporations  

A foreign corporation (non-U.S. person) is subject to U.S. federal income tax only on U.S.-source income, which generally falls into two categories: fixed or determinable annual or periodic income (FDAPI) and effectively connected income (ECI).  FDAPI includes passive income such as interest, dividends, rents, royalties, and similar items, and is taxed on a gross basis at a flat 30% rate, typically collected through withholding by the payor.  This rate may be reduced or eliminated under an applicable income tax treaty.  In contrast, ECI is taxed on a net basis at regular graduated rates, allowing deductions, but only if the foreign corporation is considered engaged in a U.S. trade or business.  

Whether a foreign corporation has a U.S. trade or business is determined based on facts and circumstances, requiring activities in the United States that are regular, continuous, and profit-driven.  Indicators include maintaining a U.S. office or physical presence, having employees or dependent agents conducting core business activities, or otherwise maintaining a substantive U.S. presence.  Conversely, a corporation with no U.S. office, personnel, or dependent agents is generally not treated as engaging in a U.S. trade or business, in which case it typically has no ECI and no U.S. filing obligation.  

Special rules apply to the sourcing of income from inventory sales and the use of agents.  Income from produced inventory is generally sourced to where production activities occur, allowing foreign-source treatment if production and assets are entirely located abroad, even if products are sold to U.S. customers.  However, having a fixed place of business in the U.S. (e.g., U.S. office or dependent agent) that materially contributes to sales may create ECI exposure.  These principles are added to tax treaties through permanent establishment provisions, generally limiting U.S. taxation to cases where a fixed place of business or dependent agent exists.  The use of independent agents in the U.S. may help avoid generating ECI or establishing a U.S. trade or business.    

In addition, foreign corporations earning ECI may be subject to a branch profits tax, generally 30%, on earnings not reinvested in the United States, functioning similarly to a dividend withholding tax.  

State Sales Tax Rules 

State sales tax obligations are governed by the concept of “sales tax nexus,” which determines whether a business must collect and remit sales tax in a particular state. Nexus can arise from a variety of activities, including maintaining a physical presence such as an office, warehouse, or inventory; having personnel or contractors operating in the state; engaging affiliates or advertising arrangements; or participating in activities such as trade shows or drop-shipping relationships.  These rules apply equally to U.S. and non-U.S. businesses – any company with sufficient connection to a state may be required to collect sales tax from in-state customers.  

A major shift in these rules occurred following the 2018 U.S. Supreme Court decision in South Dakota v. Wayfair, which established that physical presence is no longer required to create nexus.  Instead, states may impose sales tax obligations based on “economic nexus,” meaning that sellers exceeding certain thresholds of sales or transactions into a state must collect and remit sales tax.  This framework primarily affects e-commerce businesses that sell remotely through their own websites or third-party platforms.  

Most states have adopted economic nexus thresholds similar to those upheld in Wayfair, commonly set at $100,000 in annual sales into the state and/or 200 separate transactions.  Additionally, many states impose obligations on marketplace facilitators, such as Amazon, to collect and remit sales tax on behalf of third-party sellers.  However, even when marketplace facilitators handle collection, sellers that are registered in a state are typically still required to report those sales on their sales tax filings.  

State Income Tax Rules 

State income tax obligations for foreign and multistate corporations are determined independently from federal tax rules.  As a result, even if a foreign corporation is not engaged in a U.S. trade or business and has no federal filing requirement, it may still be subject to state income tax and filing obligations.  Each state applies its own nexus standards, generally requiring a sufficient level of in-state activity or “contacts” before imposing tax.  In practice, most businesses are taxable in only a limited number of states, making it essential for multistate companies, particularly e-commerce businesses, to identify where they have nexus based on factors such as sales volume, property, employees, agents, or the use of intangible assets.  

Similar to sales tax concepts, income tax nexus may arise through physical presence or economic activity.  Physical presence, such as offices, employees, inventory, or agents in a state, typically creates nexus, but many states also assert nexus based on economic presence alone, such as exceeding specified sales thresholds.  Additionally, the use or licensing of intangible property (e.g., trademarks or intellectual property) within a state can create nexus even without a physical footprint.  Some states further attribute nexus through related-party relationships or agency arrangements, particularly where affiliated entities operate within the state on behalf of the taxpayer.  

A limited federal safe harbor under Public Law 86-272 protects certain sellers of tangible personal property from state income tax if their interstate activities within a state are limited to soliciting orders, with approval and fulfillment occurring outside the state.  However, this protection is narrow: engaging in activities beyond solicitation—such as post-sale support, maintaining inventory, or using marketplace facilitators with in-state fulfillment—can eliminate the shield.  Importantly, Public Law 86-272 does not apply to foreign corporations (since the statute applies only to interstate commerce and does not cover foreign commerce), service providers, or sellers of intangible goods, and does not protect against taxes based on gross receipts or minimum taxes.    

For income derived from non‑tangible personal property, state tax treatment can vary significantly.  Many states historically have not imposed tax on services, but the rise of cloud computing has complicated this analysis.  Offerings such as Software as a Service (SaaS), Platform as a Service (PaaS), and Infrastructure as a Service (IaaS) are treated inconsistently across jurisdictions – some states classify them as taxable products, others as non-taxable services, and some lack clear guidance altogether.  Given this variability, multistate businesses must carefully review the specific rules in each state where they operate or sell.  This includes evaluating how each state characterizes cloud-based offerings as well as determining whether the company has nexus that triggers filing, registration, and tax obligations.  

Takeaways 

In today’s business environment, companies can easily reach customers across borders, often without maintaining physical offices, while employees operate remotely across multiple states.  As businesses expand, both U.S. and foreign companies must proactively assess the federal and state tax implications of their activities to ensure compliance and avoid unexpected liabilities.  In particular, foreign and multistate businesses should carefully evaluate both physical and economic presence standards when determining their exposure to U.S. federal income tax, state income tax, and state sales tax.  This includes analyzing the nature of their activities, the sourcing of income, the use of agents or affiliates, and evolving nexus standards across states.  Given the complexity and variation in state rules—especially in areas such as e-commerce and cloud-based services—ongoing monitoring and strategic tax planning are essential to effectively manage risk and maintain compliance in a rapidly changing tax landscape.